Stimulus efforts in Asia could weigh on markets here

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“We don’t just need a change in attitude when it comes to inflation and monetary policy,” Kenneth Lowe, of Matthews Asian Growth & Income fund, said. “Structural reforms are needed to create sustainable growth.”

By Mark JewellAssociated Press
May 12, 2013

Investors are worried about the slow pace of US economic growth, but we’re just one player in the international arena. To assess the global outlook, two numbers are critical: China’s gross domestic product and Japan’s inflation rate.

They’re important because China and Japan are the world’s second- and third-largest economies, and both are faltering. The outlooks in both countries could continue to have a big impact on stocks around the world as Chinese and Japanese policy makers try to stimulate their economies.

Mutual fund manager Kenneth Lowe acknowledges that China’s growth and Japan’s inflation are key numbers to watch. But he’s taking a deeper look. As the comanager of 5-star-rated Matthews Asian Growth & Income he knows that stimulus measures can juice an economy in the short term. But quarterly GDP or inflation figures don’t reveal much about the long-term outlook.

In Japan, for example, ‘‘We don’t just need a change in attitude when it comes to inflation and monetary policy,’’ Lowe says. ‘‘Structural reforms are needed to create sustainable growth.’’

Japanese Prime Minister Shinzo Abe is trying to break a long bout of deflation by getting prices on an upward track. The government has targeted a 2 percent inflation rate, a far cry from the latest reported rate of 0.9 percent deflation.

Abe’s monetary stimulus campaign has fueled a market rally and Japan’s main stock index has climbed to nearly a five-year high. Mutual funds specializing in Japanese stocks have returned almost 29 percent this year, on average, more than double the next-best international fund category, according to Morningstar.

The challenge is much different for the political leaders who recently came to power in China, led by President Xi Jinping.

‘We don’t just need a change in attitude when it comes to inflation and monetary policy. Structural reforms are needed to create sustainable growth.’

The Chinese economy continues to grow, but at its slowest pace since emerging from the 2008 global financial crisis. GDP — the economy’s total output of goods and services — expanded at a 7.7 percent annual rate in the first three months of this year. Although that’s far above the US growth rate, it’s down from the previous quarter’s 7.9 percent, and a sharp pullback from the double-digit rates of the past decade. Recent data have been mixed, raising doubts about China’s ability to climb out of its slump.

Lowe, a longtime Asian investing specialist who’s also lead manager of the newly launched Matthews Asia Focus fund, discussed his outlook in an interview last week:

What’s your take on Japan’s massive stimulus program?

It’s aggressive not just in terms of rhetoric, but in action. That’s something we haven’t seen in Japan during two decades of economic stagnation.

Are there key issues that the program doesn’t address?

The need for fundamental economic reform, which is arguably more important than monetary and fiscal changes. Japan’s economic weakness has been in large part due to demographics, with its shrinking working-age population.

That challenge will remain, so it’s very important for Japan to take steps to make it easier to do business, both domestically and with trading partners. For example, Japan could encourage a trans-Pacific partnership with the rest of Asia and the United States to make it easier to do cross-border trading. But we don’t have much clarity on what reforms will be made in Japan. It’s the big unanswered question.

What are some other steps Japan could take?

There needs to be a shift in the mentality of the Japanese consumer to encourage greater spending, and wages need to rise to help bring that about. We’ve recently had a couple instances where companies increased wages around 2 to 4 percent.

That’s a lot higher than we’ve seen historically in Japan. But it’s difficult to say whether it will be sustainable, and whether other companies will increase wages. So we don’t yet see inflation working its way throughout Japan’s economy.

Is Japan’s goal of a 2 percent inflation rate within two years attainable?

It’s an aspirational target. But even if it isn’t reached, anything is better than deflation. It they get halfway there, to 1 percent, and there’s a change in inflation expectations, it would be positive for the economy.

As a fund manager, how has this year’s Japanese stock market rally affected how you invest there?

The run-up may be difficult to justify in some segments of the market. We’re trying to avoid areas where we’re not seeing positive structural changes. We analyze stocks of individual companies on a bottoms-up basis, and we’re investing for the long term. So we don’t need to buy into aggressive rallies. But if we see opportunities with specific Japanese companies, we’ll try to participate.

Now to your thoughts on China. Do your growth expectations there affect your investment approach?

They don’t, really. Historically, high growth rates in China haven’t necessarily resulted in strong investment returns, and that’s not specific just to China. But there can be good opportunities, even if economic growth slows to 6 percent.

The medium- and long-term market outlooks could improve significantly if China can rebalance its economy. The key is to reshape the economy so that it’s based more on domestic consumption and less on exports and infrastructure.

Would such a shift hurt China’s manufacturing sector, which generates so much export activity?

The low-wage manufacturing sector may suffer, but China will make up for that loss in other areas where there’s greater economic potential, and where wages are higher. That will help fuel greater consumption by consumers, which China needs.

It’s not just the obvious stuff like food, but segments like leisure and travel and life insurance. There is a host of investment opportunities in China based around the domestic economy that most people dismiss. That’s because they’re focused on China’s infrastructure growth in areas like real estate development and highway and rail construction.

What’s another key challenge for China?

In the early days of China’s new political leadership, we’ve seen plans for a fairly aggressive crackdown on corruption. They need to continue on that path, and they also need to make it easier for private enterprises to do business. That will require cutting red tape and improving access to financing.